Journal article

Optimal internal control regulation: Standards, penalties, and leniency in enforcement

Stefan Schantl, Alfred Wagenhoferb

Journal of Accounting and Public Policy | Elsevier | Published : 2021

Abstract

To protect investors, regulators increasingly rely on regulating firms’ internal controls over financial reporting, but they punish noncompliance only if an internal control weakness enabled accounting manipulation. In other words, enforcement is manipulation-contingent. We develop an economic model with a manager who sequentially chooses internal control quality and manipulative effort, and a welfare-maximizing regulator who determines an internal control standard, the penalty size for internal control weaknesses, and when to invoke such a penalty. Internal control regulation under manipulation-contingent enforcement not only provides incentives to invest in internal controls, but also impr..

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University of Melbourne Researchers